A look at the DeFi insurance landscape, and why most assets are still uninsured

5 min readJun 27, 2021

Replacing outmoded, inaccessible and corrupt financial markets with innovative, open and unmediated ones has been a dominant narrative in crypto since Bitcoin’s whitepaper first appeared. In the past year, decentralized finance (DeFi) has embodied this message and taken Satoshi Nakamoto’s vision of peer-to-peer electronic cash to an ambitious new end: a global ecosystem of financial tools and services that’s more accessible, transparent, and democratic than traditional finance (TradFi).

In June 2020, DeFi’s total value locked (TVL), or assets secured by smart contracts, surpassed $1 billion [DeFi Pulse]. That figure peaked at around $145 billion in May 2021 and has since floated around $100 billion [DeFiLlama]. This acceleration often overshadows some of DeFi’s weaknesses, particularly regarding asset protection. While other finance cornerstones like saving, borrowing and trading have seen notable progress, decentralized insurance looks oddly similar to what we saw one year ago.

As of today, DeFi insurance platforms have under $1 billion locked in their smart contracts. In other words, less than 1% of all DeFi assets have coverage against salient risks like smart contract exploits and stablecoin de-peggings. Given the innovative leaps made across the DeFi sector, it’s unclear why insurance — a fundamental and frequently mandated part of TradFi — failed to keep pace.

Bringing DeFi up to speed

Barring any regulatory changes, DeFi looks poised to grow and evolve in the coming years. Decentralized doesn’t mean detached, however, and the budding crypto space will likely see the same cycles as the rest of crypto: battered, bruised, then bolstered by price volatility. The truth is that DeFi hasn’t matured enough to know much with certainty except the ever-present need to keep your crypto protected.

TradFi uses several strategies to calculate, limit or soften the cost of damages, most frequently packaged as insurance. Basic elements of TradFi, such as borrowing and trading, have been successfully reimagined for the blockchain, but no leader has emerged in the race to build scalable, robust insurance for digital assets. Developers have tried dozens of different risk-sharing models, so if it’s not a problem of effort, what is it?

One consideration is the high-risk tolerance of DeFi users. Experienced DeFi traders and yield farmers understand the risks they take when using various protocols. High-interest yields incentivize liquidity providers to participate, and insurance platforms rarely offer APYs comparable to other DeFi protocols. Even if they protect their long-term interests, low rewards will stop most high-risk tolerance users from parking large sums of capital.

Another possibility is simply a lack of cost-efficient options. User-centric insurance models, which place the burden of insurance on individuals, do seem excessive when paired with costly premiums and substandard coverage. Moreover, would there be enough liquidity to pay out all those affected by something as significant as a stablecoin de-peg?

Hashing out the differences

Developers have tried various mechanisms to build safe, scalable, and profitable digital asset protection. Most decentralized insurance projects use conventional ideas from TradFi and readjust them as needed. This creates another problem for current insurance solutions: antiquated ideas can only go so far in solving contemporary issues.

DeFi insurance usually comes as a type of property insurance that compensates the policyholder for economic losses. However, the key difference is a focus on decentralizing the payment, actuarial, and claims processes. When this fails, governance usually steps in due to the complexity of decentralizing each procedure.

Below we’ll look at Nexus Mutual and Cover Protocol, two projects which exemplify some of the strengths and weaknesses of current DeFi insurance models.

*Data sourced on June 22, 2021 from* *DeFiLlama*

Nexus Mutual

Of the current insurance platforms available, Nexus Mutual has been arguably the most successful. As the name suggests, Nexus Mutual employs mutual funds — diversified pools of assets owned by a group — to protect policyholders against yield token de-pegging, protocol hacks, and custody risks. Although the mutual fund mechanism works for some individual users, it isn’t efficient or scalable enough to suit the broader DeFi community. Furthermore, the underwriter controls the claims process, an apparent conflict of interest that allows a valid claim to be denied. Like traditional insurance, Nexus Mutual commodifies risk and sells it as a package, forcing prospective policyholders to speculate on their risk rather than relying on data to inform them about it. Lastly, it has a cumbersome and inefficient claims process that fails to suit the needs of DeFi.

Cover Protocol

Cover protocol, a peer-to-peer insurance market, excels in some areas that Nexus Mutual falters: breadth of coverage, accessibility, and rewards. Cover Protocol enables users to create insurance contracts for just about anything. Unlike Nexus mutual, Cover Protocol doesn’t require users to submit KYC (“know your customer”) information, meaning anyone can participate. The biggest issue with Cover Protocol (aside from being hacked multiple times) is that it doesn’t provide or require any data to create a coverage policy; the underwriter can set the premium at whatever price they want. Without data for the actuarial process, users must rely on too much guesswork. In the end, Cover Protocol amounts to little more than a speculative marketplace for IOUs.

Using the past and present to build the future

The Steady State team believes that DeFi insurance will play a pivotal role in adopting alternative financial markets. When it comes to asset protection, platforms like Nexus Mutual and Cover Protocol provide indications of what works and what doesn’t. Ultimately, we can leverage this knowledge to understand the needs and wants of each counterparty.

Steady State seeks to be the first insurance platform to fix the problems outlined above, from inadequate data to inefficient processes and limited coverage. By rewarding users for insuring protocols, Steady State can gather liquidity from both counterparties and direct it toward the simple goal of covering as much TVL as possible. We believe the adoption of DeFi will grow even more rapidly once we have comprehensive and fit-for-purpose decentralized insurance, making Steady State poised to secure the future of finance.

About Steady State

Steady State gives DeFi protocols and platforms a practical solution to safeguard their financial future. With the help of Chainlink Keeper technology, our platform aims to eliminate bottlenecks in DeFi insurance by using automated processes, shared coverage policies, and a cutting-edge risk analysis database. Steady State is creating a new paradigm for decentralized insurance by delivering DeFi’s best-ever insurance platform for protocols.

To learn more about Steady State and the impact of our pragmatic approach to Defi insurance, visit us at the links below:

Steady State cautions that statements in this communication that are forward-looking, and provide information other than historical information, involve risks, contingencies and uncertainties that may impact actual results of operations and prospective transactions.